Empirical Analysis Of Linkages Between Shanghai And Bombay Stock Markets

This paper explores the possible linkages between Shanghai and Bombay stock markets, accounting for complimentarity (through direct linkages) and substitutability (through indirect linkages) features between China and India to confirm real linkages in physical world. We employ a Dynamic OLS estimation proposed by Stock and Watson (1994) to estimate long run relationship between two variables. Considering the long memory feature of financial data, we apply the ARFIMA regression to our cointegrated residual derived from Dynamic OLS estimation. While differencing cointegrated residual with fractionally integrated order of d value,we estimate the long term and short dynamic relations of index returns in two stock markets, with the help of VECM equation. Furthermore, we apply a DCC-MGARCH model to analyze ARCH effect, GARCH effect, and volatility transmission between two stock markets. We use Quantile regression approach to study dependence structure and intensity at different quantiles between two markets. Dummy variables are taken to distinguish pre-crisis periods and in crisis, post-crisis periods.

Two sovereign nations have ties through two main means, one is economic and cultural bonds established by their own governments and people, the other is indirect trilateral-multilateral associations among three and mutlinations. The first case is like in European countries, they have strong economic and cultural links with each other in history, so, interdependence intensity is rather high;The second case is like Mongolia in North East Asia, she does not have strong economic relations with India, in comparison with her neighboring countries, China and Russia. However, because both of China and Russia have more interactions with both Mongolia and India bilaterally, then, the two relatively separated nations are involved in economic activities related to them indirectly.

With globalization further deepening, individual country economy is gradually integrated into the world economy to some extent. International trade and capital flow as two powerful tools, are utilized to efficiently allocate resources under global framework. Efficient stock markets are rather sensitive to investors’ expectation, which is based on publicly released information from related sources. Communication technologies advancements, make simultaneous responses to the latest news possible in different markets. More and more normally, when a market gets a negative impulse, some other markets would have some similar patterns of price movement. A vast of researches show that spillover effects of the return and volatility in stock markets are present.

China and India are two most populous countries in the world. Their stock markets are ranked top 10 in terms of market capital. Up to Sep, 2015, the total market capital in Chinese stock markets including Shanghai and Shenzhen stock markets is about 6 trillion dollars, 3 trillion dollars in Indian stock markets including Bombay and National stock markets. There are thousands of companies listed in four stock markets, healthy development of stock markets is essential for starting-capital accumulation and distribution of economic dividends. The financial deepening indicator derived through stock market capital/total GDP in China and India is 0. 58 and 1. 5 respectively(Fig 1). It shows that Indian stock markets have been developed at a higher speed than her economic progress. Whether we accept it or not, the importance of stock markets in both countries is never overemphasized.

Given economic growth potentials in the two countries, their global economic influence will become larger and larger. In addition to that, economic liberalization and more and more openness to global capital market, will provide huge opportunities for foreign investors to allocate their assets in a more effective way. To empirically study two stock markets is in immediate demand, it will also improve the predictability of domestic stock market performance, through observation of the atmosphere in the other market. Whether stock markets in China and India have interactions or not? Which indicators should be taken to confirm a real linkage either in direct or in indirect way in the two markets? If there is interaction, whether is unidirectional or bilateral? If it is unidirectional, what is the transmission mechanism from one side to the other side? Whether their relations are constant in pre-crisis periods and post-crisis periods? With series of questions, this paper mainly focuses on three aspects related to Shanghai and Bombay stock markets. It also guides our section framework arrangement, each section is aimed at solving one of the three questions.